CHAPTER 1 : COST MANAGEMENT -- AN OVERVIEW

QUESTIONS

1-1 Firms Using Cost Management. Here are some examples; there are many possible
answers.
1. Wal-Mart: to keep costs low by streamlining restocking and sales
2. COMPAQ: to keep costs low by improving manufacturing performance and by using
target costing and other management techniques
3. Citicorp: to keep costs low by using activity analysis (see problem 1-20) to identify
key operations and to find those that add little or no value
4. A local school district or public agency: to keep costs low in order to provide the best
possible service given available funds
5. Procter & Gamble: to assess the profitability of its different products
6. Any other large, diversified manufacturer, like Procter & Gamble: which needs to be
able to analyze the relative profitability of its different products, using cost management
7. A small machine shop: which needs cost management to determine whether it should
repair or replace a machine
8. A dance studio: to analyze and choose between different compensation plans for its
teacher; and to determine whether it should open a new studio

1-2 Firms not expected to be significant users of cost management information:

1. Microsoft: here the focus is on forming strategic alliances, innovation and
competition; cost management is more important for other firms in the information
technology business, such as COMPAQ, Hewlett Packard, and IBM that compete in
part on innovation but also on price
2. Versace: a high fashion firm competes on innovation and product leadership; the
development and communication of attractive new ideas is the key to competitive
success rather than cost management
3. Other firms in the fashion industry, such as Chanel, Givency, and Armani: for reasons
similar to Versace
4. Major league sports: dependent primarily on the development of fan support, good
coaching and player acquisition

1-3 Cost management information is a broad concept. It is the information the manager
needs to effectively manage the firm or not-for-profit organization -- both financial
information about costs and revenues and relevant non-financial information about
productivity, quality, and other key success factors for the firm. Typically, cost
management is the responsibility of the Chief Financial Officer (CFO) who often
delegates much of this responsibility to the Controller.

1-4 In the private sector, the Financial Accounting Standards Board, an independent
organization, and the American Institute of Certified Public Accountants (AICPA) supply
guidance regarding financial reporting practices. The AICPA also provides educational
opportunities. In the public sector, The Cost Accounting Standards Board (CASB) sets
cost accounting standards for those doing business with the federal government,
especially defense contractors. The Institute of Management Accountants (IMA) is the
principal organization devoted primarily to management accountants in the United
States. The IMA has magazines, newsletters, research reports, management
accounting practice reports, professional development seminars, and monthly technical

Blocher, Chen, Lin: Cost Management 1-1 ©The McGraw-Hill Companies, Inc., 2002
 meetings that serve the broad purpose of providing continuing educational opportunities
for management accountants. In Canada, the Society of Management Accountants
provides a similar role. Similar organizations are present in most other countries around
the world. The Financial Executive Institute (FEI) provides services much like the IMA
for financial managers, including controllers and treasurers. Because of the nature of its
membership, the FEI tends to focus on management and operational control issues,
and less on the product costing, planning, and decision-making functions.

1-5 The Certificate in Management Accounting (CMA) is the most relevant certification
program for management accountants since it focuses on the types of skills that are
most in demand for management accountants: economics, finance, and management,
financial accounting and reporting, management analysis and reporting, and decision
analysis and information systems. Other relevant certifications include Certificate in
Financial Management (CFM) and the Certified Public Accountant (CPA).

1-6 The four functions of management are:

1. Strategic Management -- information is needed by management to make sound
strategic decisions regarding choice of products, manufacturing methods, marketing
techniques and channels, and other long term issues.
2. Planning and Decision Making -- information is needed to support recurring decisions
regarding replacement of equipment, managing cash flow, budgeting raw materials
purchases, scheduling production, and pricing.
3. Management and Operational Control -- information is needed to provide a fair and
effective basis for identifying inefficient operations, and to reward and support the most
effective managers.
4. Preparation of Financial Statements -- information is needed to provide accurate
accounting for inventory and other assets, in compliance with reporting requirements,
for the preparation of financial reports and for use in the three other management
functions.

1-7 Strategic management is the most important management function since it most directly
relates to the overall success of the firm. In strategic management, top managers
determine how the firm is to compete and what specific goals it must set and achieve to
be successful. The determination of these strategies and goals drives all other activities
in the firm.

1-8 Merchandising firms purchase goods for resale. Merchandisers that sell to other
merchandisers are called wholesalers, while those selling directly to consumers are
called retailers. Examples of merchandising firms include the large retailers, such as
Sears, Wal-Mart, and Radio Shack. Merchandisers use cost management information
to control stocking, distribution, and customer service.
Manufacturing firms use raw materials, labor, and manufacturing facilities and
equipment to produce products. These products are sold to merchandising firms or to
other manufacturers as raw materials for additional products. Examples of
manufacturers include General Motors, IBM, and Sony. These firms use cost
management information to control production costs.
Service firms provide a service to customers that offers convenience, freedom,
safety, or comfort. Common services include transportation, financial services (banking,
insurance, accounting), personal services (physical training, hair styling), medical

Blocher, Chen, Lin: Cost Management 1-2 ©The McGraw-Hill Companies, Inc., 2002
 services, and legal services. These firms use cost management information to identify
profitable services and to control costs incurred in providing services.
Governmental and not-for-profit organizations provide services, much like the
firms in service industries. However, the service provided by these organizations is
such that there is often no direct relationship between the amount paid and the services
provided. Instead, both the nature of the services to be provided and the customers to
receive the service are determined by government or philanthropic organizations.
These organizations use cost management information to determine and control the
costs of the services they provide.

1-9 The answers here can vary from large manufacturers such as COMPAQ to small retail
stores. If the class has trouble getting started, the instructor might use some of the
firms mentioned in question 1-1, or from the instructor’s own experience and
understanding. Again, if the students have a hard time, the instructor might ask them to
think of firms close to their homes, or to think of firms in a given industry, etc.

1-10 As firms move to the Internet for sales and customer service it is likely that strategies
will change. For some firms, a popular web site can be an important differentiating
factor. Firms such as Amazon.com, Etrade and eBay have achieved powerful
competitive advantage through the strength of their web sites. Other firms might use
the Internet to achieve cost advantage, by us Internet based systems for transactions
processing, production scheduling, purchasing, employee recruiting, etc. It seems that
the Internet could be effectively used to enhance either a cost leadership or product
leadership strategy.

1-11 As firms move to the Internet for sales and customer service it is likely that their demand
for cost management information will change. For example, order processing costs are
likely to change dramatically. In the web-based environment, costs are likely to
increase rapidly at first as new investments are made, but unit (per transaction) costs
are likely to rise until the technology is in place and functioning, and then unit costs will
come down as volume builds. From a strategic standpoint, the key issues may be
customer service, speed of response and reliability which can be achieved through the
web-site. Whether and how soon the firm can achieve these benefits is a critical
question.

1-12 The factors in the contemporary business environment that affect business firms and
cost management are:
1. Increased global competition, which means an increasingly competitive environment
for all firms and thus the need for cost management information to become more
competitive; the need for competitive non-financial information in addition to financial
information in cost management reports;
2. Changes in manufacturing and information technologies, and thus the need for cost
management information to facilitate the introduction of new manufacturing and product
technologies (e.g., determining which technologies will most contribute to profitability),
and to incorporate in cost management reports the information needed to manage the
new technologies effectively; the importance of life cycle costing -- considering the total
costs of the product or service over its entire cost life cycle, from raw materials to sales
and service;

Blocher, Chen, Lin: Cost Management 1-3 ©The McGraw-Hill Companies, Inc., 2002
 3. A focus on the customer, which requires cost management reports to include critical
information about customer satisfaction, changing customer preferences, etc.;
4. Changes in management organizations, new reporting practices to recognize the new
focus on cross-functional teams in which employees from all areas of the firm work
together to make the firm successful;
5. Changes in the social, political, and cultural environment of business, which requires
an expansion of cost management reporting to include critical success factors related to
the expectations of those beyond the ownership of the firm including employees, local
government officials, and community leaders.

1-13 Refer to Exhibit 1-2 in the text, reproduced here.

Comparison of Prior and Contemporary Business Environments

The Prior Business The Contemporary

Environment Business Environment

MANUFACTURING

Basis of Competition economies of scale, quality, functionality,

standardization customer satisfaction

Manufacturing Process high volume, long low volume, short production

production runs, run, focus on reducing
significant levels of in- inventory levels and other
process and finished non value-added activities
inventory and costs

Manufacturing assembly line robotics, flexible

Technology automation, isolated manufacturing systems,
technology applications integrated technology
applications connected by
network

Required Labor Skills machine paced, low- individual and team paced,
level skills high-level skills

Emphasis on Quality acceptance of a normal strive for zero defects

or usual amount of
waste

Blocher, Chen, Lin: Cost Management 1-4 ©The McGraw-Hill Companies, Inc., 2002
Question 1-13 (continued)

MARKETING

Products relatively few variations, large number of variations,

long product life cycles short product life cycles

Markets largely domestic global

MANAGEMENT
ORGANIZATION

Types of Cost almost exclusively financial and operating data,

Management financial data the firm's strategic success
Information Needed factors

Management hierarchical; command network-based organization

Organizational and control forms; teamwork focus --
Structure employee has more
responsibility and control;
coaching rather than
command and control

Management Focus short term: short term long term; focus on critical
performance measures success factors, commitment
and compensation; to the long term success of
concern for sustaining the firm, including adding
stock price; short tenure shareholder value
and high mobility of top
managers

1-14 The ten contemporary management techniques are:

1. Benchmarking, a process by which a firm identifies its critical success factors, studies
the best practices of other firms (or other units within a firm) for these critical success
factors, and then implements improvements in the firm's processes to match or beat the
performance of its competitors.
2.Total Quality Management, a technique in which management develops policies and
practices to ensure that the firm's products and services exceed the customer's
expectations.
3.Continuous Improvement, a management technique in which managers and workers
commit to a program of continuous improvement in quality and other critical success
factors.
4.Activity-based Costing and Management: Activity-based costing is used to improve
the tracing of manufacturing costs to products and therefore the accuracy of product

Blocher, Chen, Lin: Cost Management 1-5 ©The McGraw-Hill Companies, Inc., 2002
 costs. Activity-based management (ABM) uses activity analysis to improve operational
control and management control.
5. Reengineering, a process for creating competitive advantage in which a firm
reorganizes its operating and management functions, often with the result that jobs are
modified, combined, or eliminated.
6. The Theory of Constraints, a strategic technique to help firms to effectively improve
the rate at which raw material are converted to finished product.
7. Mass Customization, a management technique in which marketing and production
processes are designed to handle the increased variety of delivering customized
products and services to customers.
8. Target Costing, a management technique that determines the desired cost for a
product upon the basis of a given competitive price, such that the product will earn a
desired profit.
9. Life-Cycle Costing, a management technique used to monitor the costs of a product
throughout its life cycle.
10. The Balanced Scorecard, an accounting report that includes the firm’s critical
success factors in four areas: customer satisfaction, financial performance, internal
business processes, and innovation and learning (human resources).

Blocher, Chen, Lin: Cost Management 1-6 ©The McGraw-Hill Companies, Inc., 2002